Systemic Liquidity Risk and Bipolar Markets: Wealth Management in Today's Macro Risk On/Risk Off Financial Environment

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Mainstream Financial Economics Groping Towards a New Paradigm

One of the more severe consequences of a failure to have an appropriate explanatory framework for the booms and busts so evident in economic history and, to use Richard Koo’s nomenclature, the current global “balance sheet recession,” is a lamentable disregard for the insidious dynamics which have led to a disappearance of income. In addition to addressing this malaise of recent economic times it will also be useful to consider some other macro-economic phenomena which are poorly, if at all, explicable in the mainstream theory of financial economics. This chapter will examine some of these hard to explain and awkward predicaments, and, in the latter section, we can turn to some new initiatives that are being shown by a growing number of macro-economists who are proclaiming that a new paradigm of economic thinking is emerging to supersede the fundamentally flawed orthodoxy which still prevails.

The naïve view expressed by “laissez faire” economics, is that, to simplify matters, but not indefensibly so, the economic system can be best understood using concepts that are essentially similar to those outlined in the textbooks of 19th and 20th century classical economics. This is a world, familiar to anyone who has studied even high school economics, of demand and supply diagrams, markets which tend towards equilibrium, and where individuals, as economic agents, seek to maximize their utility – itself an imprecise concept ...